Board of Trustees of Maryland Teachers & State Employees Supplemental Retirement Plans v. Life & Health Insurance Guaranty Corp.

RODOWSKY, Judge. The question presented here is whether two guaranteed investment contracts (GICs) issued to the Board of Trustees of the Maryland Teachers and State Employees Supplemental Retirement Plans (the Board) by Executive Life Insurance Company (ELIC) constituted “covered policies” under the Life and Health Insurance Guaranty Corporation Act, Maryland Code (1957,1994 RepLVol.), Art. 48A, §§ 520 through 537 (the Guaranty Act). The answer to the question presented turns on the construction of Art. 48A, § 65, defining “annuities” and an “annuity contract.” 1 The Board, created in 1985, is charged with “[t]he general administration and responsibility for the proper operation of’ certain supplemental compensation plans for state employees and teachers, including a deferred compensation plan for state employees. Md.Code (1957, 1988 Repl.VoL, 1993 Cum.Supp.), Art. 73C, §§ 2 and 5(a).

A deferred compensation plan initially had been established under an executive order in 1974, and that plan is continued by the Board. Art. 73C, § 5(b). The document that the parties have utilized in the instant litigation to evidence the terms of the plan is The Maryland State Employees Deferred Compensation Plan, as amended and restated in 1988 (the Plan). The Plan is designed to comply with § 457 of the Internal Revenue Code.

Under the Internal Revenue Code income tax is deferred on the amounts consensually withheld from employees and paid into the Plan, and access by a participant to the funds in that person’s Plan account is restricted. ¹⁸⁰ One function of the Board is to invest the deferrals of Plan participants. Participants select the type or types of investments for their respective deferrals from a menu of investment options offered by the Board from time to time. One option has been a fixed income investment. GICs are .fixed income investments.

The Board purchased two GICs from ELIC on separate occasions in 1987. The earlier purchase is Group Annuity Contract No. GAGICO1209 and the later is Group Annuity Contract No. GACG012443A. The premium for the earlier policy is the deferrals for the period from January 1 through April 15, 1987, up to a maximum of $6 million in deferrals of Plan participants who selected the fixed income investment option. ELIC agreed to pay interest at the rate of 8.25%, credited and compounded daily, until the maturity of that contract on December 31, 1991, when ELIC would pay the Board “the fund value.” 2 The GIC purchased later from ELIC was issued October 2, 1987, with a guaranteed interest rate of 10.05%, a premium deposit period from October 1 to December 31, 1987, a premium deposit limit of $9 million, and a maturity date of September 30, 1992.

In other respects the provisions of the two GICs are substantially the same. ELIC is a California-domiciled life insurance company that was authorized to transact annuity business in Maryland. “Since the latter part of 1989, [ELIC] began to report significant reductions in the market value of [its] investment portfolios and increased defaults of high yield securities.” 1993 Best’s Insurance Reports-Life/Health 884. On April 11, 1991, the California Insurance Commissioner placed ELIC in conservatorship, and on December 6, 1991, ELIC was declared insolvent. A plan of rehabilitation has been approved under which it appears that the Board will suffer a loss on its ELIC GICs. ¹⁸¹ The Guaranty Act was first enacted in 1971.

As amended, its purpose “is to protect residents who are policyowners, insureds, beneficiaries, annuitants, payees, and assignees of life insurance policies, health insurance policies, [and] annuity contracts ... against failure in the performance of contractual obligations due to the impairment of the insurer issuing these policies or contracts.” § 521. Section 522(1) makes the Guaranty Act applicable to “direct life insurance policies, health insurance policies, annuity contracts, and contracts supplemental to ... annuity contracts issued by persons authorized to transact insurance in this State,” with certain exceptions not relevant here. A policy described in § 522 is a “ ‘[c]overed policy’ ” under the Guaranty Act. § 524(4). Section 525(1) creates the Life and Health Insurance Guaranty Corporation (the Corporation) to administer the Guaranty Act.

If a foreign insurer is under an order of liquidation, the Corporation shall “guarantee ... the covered policies of residents” and “[a]ssure payment of the contractual obligations of the impaired insurer to residents.” § 527(4)(a). In order to raise the funds necessary to carry out its duties, the Corporation is empowered to levy assessments on insurers writing covered policies in Maryland. § 528. For purposes of administration and assessment the Corporation maintains three accounts: health, life, and annuity. § 525(1). Assessments arising from the failure of an impaired foreign insurer are made “against member insurers for each account ... in the proportion that the premium received on business in this State by each assessed member insurer on policies covered by each account bears to such premiums received on business in this State by all assessed member insurers.” § 528(3)(b).

Following the order for ELIC’s liquidation, the Board brought the instant action against the Corporation. The Board’s complaint sought a declaratory judgment that the ELIC GICs “are annuity contracts entitled to the benefits of’ the Guaranty Act and also sought certain injunctive and monetary relief. Each party moved for a summary judgment declaring, respectively, that the ELIC GICs were or were not covered policies under the Guaranty Act. In a memorandum ¹⁸² opinion and order the circuit court’s principal conclusion was “that the ELIC GICs do not satisfy the statutory requirements for an ‘annuity contract.’ ” The Board appealed to the Court of Special Appeals and petitioned this Court to grant a writ of certiorari prior to review by the intermediate appellate court.

We granted the writ. Before this Court the Board’s position is supported by an amicus curiae brief filed by the Group Annuity Participant Protection Association (GAPPA), an unincorporated association of employment plan sponsors who have claims in the ELIC insolvency. The Corporation’s position is supported by an amicus curiae brief filed by The National Organization of Life and Health Insurance Guaranty Associations (NOLHGA). The Board contends that the GICs are covered policies because they are group annuity contracts, one of the types of policies to which the Guaranty Act applies. § 522(1). “Annuity contract” is not a term that is defined in the Guaranty Act.

The term does appear, however, in § 65 which reads: “‘Annuities’ means all agreements to make periodical payments where the making or continuance of all or some of a series of such payments, or the amount of any such payment, is dependent upon the continuance of human life____ The business of annuities shall be deemed to include additional benefits operating to safeguard the contract from lapse, or to provide a special surrender value, or special benefit, or annuity, in the event of total or permanent disability of the holder. An ‘annuity contract’ is a contract providing for an ‘annuity 1 as defined in this section.” The Corporation submits that the ELIC GICs contain no agreement to make periodic payments, and contain no agreement to make payments dependent upon the continuation of human life. The Board, on the other hand, submits that these GICs satisfy the § 65 definition because they are sold by an insurer to fund a pension plan (in the broad sense), contain an annuity option, and are generally recognized as group annui ¹⁸³ ties in the insurance industry and by the Maryland Insurance Commissioner (the Commissioner). The first step in resolving this difference of opinion is to examine the terms of the ELIC GICs and their relationship to the Plan.

For this purpose the parties have treated the two GICs as substantially the same, and utilized the text of the earlier contract. We shall do the same. Bookkeeping and recordkeeping of participants’ accounts in the Plan, service to participants, and other details of Plan administration are performed by a Plan Administrator under contract to the Board. The Plan Administrator is an affiliate of Nationwide Life Insurance Corporation (Nationwide).

Pri- or to January 1,1987, deferrals of Plan participants choosing a fixed income investment option were invested in a contract with Nationwide. Thereafter the Board sought to diversify investments of that type and to increase its return. We infer that under the diversification program the Board purchased a separate GIC in which to invest fixed income deferrals contributed during each three month period. The Plan provides for “[b]enefits through payment of a PARTICIPANT’S account balance ... upon the PARTICIPANT’S death, retirement, separation from service, the occurrence of an unforeseeable emergency causing financial hardship, or the attainment by the PARTICIPANT of age 70%, whichever shall first occur.” “ ‘Financial Hardship’ under the Plan” means “severe financial hardship to the PARTICIPANT resulting from a sudden and unexpected illness or accident of the PARTICIPANT or one or more of his dependents,” and it also means “financial hardship to the PARTICIPANT caused by loss of the PARTICIPANT’S property due to casualty. ...” With respect to the methods of payment of benefits, the Plan provides the following: “The methods of payment of benefits available for election by a PARTICIPANT shall be either: (A) a single sum payment of the entire value of the PARTICIPANT’S account; (B) an installment schedule of monthly, quarterly or ¹⁸⁴ yearly payments of a period of one or more years; (C) a series of payments on an annuity basis as if an annuity contract was purchased for such person, with payments under this option occurring either (I) over the life of the PARTICIPANT; (II) over the life of the PARTICIPANT and his spouse; (III) over the life of the PARTICIPANT and an individual other than his spouse; (IV) over the life of the PARTICIPANT and a period certain, whichever is greater.

For any PARTICIPANT who has elected any life insurance option available under the Plan, payment of benefits may be made through either distribution of cash benefits available under such policy, or, at the election of a PARTICIPANT, through distribution of a policy to such individual.” Plan participants may also change their investment options at such times as the Board is able to change its investments under the constraints of the existing investments and of the Plan Administrator’s contract. Under the subject GICs the Board, as contract owner, is in privity with ELIC. GICs in which “the insurance company has no direct contractual obligation to the [Plan] participant” are called “unallocated contracts.” Forcier, A GIC Primer: Terminology, Contract Provisions, How GICs Are Used By Plan Sponsors And Competing Products, in Investing in GICs: Navigating The Insurance Crisis 18 (P.L.I. Edgar ed. 1991) (Forcier). The ELIC GICs accommodate the exercise, before maturity of a GIC, of the participants’ transfer and withdrawal rights under their Plan accounts.

Withdrawal by the Board from a GIC is permitted “to comply with participant re-allocations among other investment funds available under the plan.” More important here, -withdrawals by the Board from a GIC in order for the Plan to pay a participant’s benefits may also be made pursuant to the following provision: “The [Board] may direct the Company to purchase an individual annuity contract for a participant before the retirement date. The Company will withdraw the cost of annuity benefits for the participant on the date it receives the [Board’s] written request. The [Board] may also with ¹⁸⁵ draw all or part of that portion of the fund value allocable to a participant, in accordance with withdrawal provisions of the Plan in effect on the Date of Issue.” (Emphasis added). The ELIC GICs also provide that the Board “may withdraw the annuity value required to purchase an annuity for a participant who retires.

The LBoard] will then apply for an individual retirement annuity contract, on a form provided by the Company. The contract will be owned by the participant, and will specify the dates and amounts of payments, and all other terms and conditions of the participant’s annuity.” Under such a single premium annuity issued directly by ELIC to the participant, the benefits include, as a minimum and at the participant’s option, a participant’s lifetime annuity, an annuity for the greater of a period certain and the participant’s life, and a joint and survivor annuity. These optional individual annuities are further described as follows: “Benefit payment amounts will be determined at the time benefits are purchased, and will be based on guaranteed tables. These tables are based on the 1971 Group Annuity Mortality Table, with 7% interest for ten years and 6% thereafter, plus an expense charge equal to the gross rate plus any premium tax payable by the Company.

The Company will provide sample annuity purchase rate tables upon request.” There is also a provision that requires all withdrawals to be made on a pro rata basis. This pro rata provision prevents the Board from attempting to obtain from an ELIC GIC the total withdrawal value of a participant’s account, particularly if the ELIC GIC’s interest rate were below that of other unmatured GICs in which the Board had invested. Thus, if a Plan participant dies, retires, or suffers severe financial hardship due to illness, ELIC could be called upon under its unmatured GICs to pay to the Board, in cash, ELIC’s pro rata share of that participant’s account in the Plan. Further, if the participant retires, becomes seriously ill, ¹⁸⁶ or dies, and the participant or the participant’s beneficiary elects an annuity, the Board could direct ELIC to issue that annuity upon payment of the appropriate premium and ELIC would be contractually obligated to comply.

The record does not reflect the actual withdrawals for Plan participants under the ELIC GICs. Nevertheless, the inference is compelling that, between contract inception and the conservatorship, withdrawals were made from ELIC GICs of each GIC’s pro rata share of the Plan accounts of dead, retired, or financially stricken participants. The record, however, is clear that no individual annuity policy was ever issued by ELIC directly to, or for the account of, any Plan participant. All of the individual annuities purchased by the Board under the Plan had been obtained from Nationwide.

It was not until 1987 that the Board, in contemplation of a competitive bidding process for individual annuities, provided in its contract with the Plan Administrator that the Board could purchase individual annuities from insurers other than Nationwide. The competitive bidding process was not administratively in place until approximately the middle of 1992. The Corporation contends that “[t]he limited withdrawal provisions in the ELIC GICs” are not “life-contingent.” Brief of Appellee at 15. We disagree.

ELIC could be called upon, whenever a participant died, to pay its pro rata share of that participant’s account in the Plan. This amount would be the initial value of the share together with interest at the guaranteed rate, compounded daily. The actual return which ELIC might have realized on its investment of the premium deposits (ie., deferrals), as of the times of demands for payments generated by death or illness of participants, could have been below the amount which ELIC had promised to pay to the Board. Thus, ELIC’s assumption of the economic risk was life-contingent.

Indeed, ELIC’s contractual assumption also included the risk, however remote, that a catastrophe or epidemic would result in the deaths of large numbers of participants in a relatively brief span of time. ¹⁸⁷ Thus, the principal issue in this case reduces itself to whether the periodic payment element of the § 65 definition of an annuity, which is incorporated into the definition of “annuity contract,” can be satisfied by the provisions in the GICs for the issuance of individual annuity policies at the option of the Board. I Under the literal language of § 65, the GICs are contracts “providing for” an annuity, because the GICs provide for options to obtain individual policies specifying life-contingent periodic payments. For example, a lease of space in an office building or in a shopping center that grants the tenant an option to expand into additional areas may be described as a lease “providing for” expansion. Similarly, a lease of a chattel with an option to purchase, either during or at the end of the term, may be considered as “providing for” purchase.

Indeed, the chairperson of the Corporation acknowledged on deposition that an individual, deferred annuity policy which provides either for the lump sum withdrawal of the cash value at maturity or for the payment of a stream of periodic payments is no less an annuity if the insured should elect payment of the cash value at maturity. The compatibility of the ELIC GICs with one connotation of the words used in the “annuity contract” definition simply clears the textual hurdle, but it is hardly conclusive where, as here, the concepts are so general. When, however, we examine Maryland’s legislative and administrative responses to the evolution of life insurance products in the funding of pensions, it becomes clear that the ELIC GICs are annuity contracts within the intent of § 65. Section 65 was enacted by Chapter 18 of the Acts of 1956 and codified as Md.Code (1951, 1956 Cum.Supp.), Art. 48A, § 149A(b).

That same enactment provided definitions for “Life Insurance,” “Accident and Sickness Insurance,” and for various aspects of the term “premium.” When the insurance industry began offering variable annuity contracts, the Attor ¹⁸⁸ ney General of Maryland, reversing an opinion reported at 44 Op.Att’y Gen. 203 (1959), ruled in 1960 that “the definition [of ‘annuities’] in our Maryland law is sufficiently broad and expanding to accommodate this newly created commodity.” 45 OpAtt’y Gen. 120, 123 (1960). The 1960 opinion pointed out that the definition of “annuities” in the Insurance Code “does not require that the payments be made of a certain or fixed amount.” Id. at 122. The 1956 definitions of “annuity” and “annuity contract” were utilized in the general revision of the insurance laws by Chapter 553 of the Acts of 1963, where they appear under the subtitle, “Kinds of insurance; limits of risk; reinsurance.” That 1956 definition is presently § 65. Thus, under the Attorney General’s opinion, the current definition is not frozen in time to the types of contracts known in the industry when the statute was enacted in 1956. 3 The evolution of forms of insurance for retirement purposes is traced by K. Walker in Guaranteed Investment Contracts: Risk Analysis and Portfolio Strategies (K. Walker 2d ed. 1992) (Walker). 4 Walker states: “As pension coverage grew, the inefficiencies and disadvantages associated with [level premium or single premium deferred annuity] individual policies required the development of a more cost-efficient investment contract.

An ¹⁸⁹ improvement occurred when the group annuity contract entered the market place.” Id. at 7. During the mid-1950s the deposit administration contract (DAC) was developed. It “revolutionized the pension industry” and provided “major improvements over the individual annuity policy.” Id. at 8. Under a DAC “[a]ll funds were pooled on an unallocated basis within the general account of the insurer until such time as the participant retired.

At retirement, funds were withdrawn to purchase an individual annuity policy for the participant, withdrawing the fully funded pension liability from the plan.” Id. A question involving the premium tax arose from the writing of DACs in Maryland by the Equitable Life Assurance Society and generated an opinion by the Attorney General. 50 OpAtt’y Gen. 235 (1965). The Attorney General described Equitable’s DAC as “a form of group annuity contract” and “typical.” Id. at 235. Under Equitable’s system the considerations were accumulated, unallocated, and applied to the purchase of individual retirement annuities if the employee’s contributions had not been refunded.

Contributions could be refunded because the employee had “become ineligible to continue in the program or elect[ed] to withdraw before his retirement date.” Id. The Attorney General ruled that the group policy was an annuity contract, one of the types of policies included under the premium tax definition of “policy.” Consequently, the premium tax was to be paid when the DAC was executed, contrary to Equitable’s contention that there was no tax due until an individual annuity policy was issued. 5 One may infer that Equitable’s group annuity-DAC did not state the amount of the periodic payments to be made to the participant, but that that specification was to be set forth in ¹⁹⁰ the individual annuity, when issued. In any event, inasmuch as “annuities” and “annuity contract” were then, as they are now, terms defined only in § 65, the Attorney General’s 1965 opinion necessarily considered DACs to be within the § 65 definition. Walker dates in the 1960s the next phase of the life insurance industry’s quest for market share in the pension marketplace.

Walker, supra, at 9. To meet the challenge from banks, the DAC “was vastly improved with the introduction of the immediate participation guarantee (IPG).” Id. “In essence, the IPG provided what its name implied: an immediate participation in the earnings, expenses, and mortality.” Id. at 9-10. “Most IPG investment contracts issued by insurance companies contained options that permitted amounts to be withdrawn ... for the purchase of annuities, for the direct payment of benefits, or for employee-directed investment changes.” Id. at 10. Then, according to Walker’s review of the metamorphosis, in the mid-1970s “aggressive competition from banks and mutual funds[,] ... the stellar performance of the equity markets[,] ... [t]he explosive growth of defined contribution plans, and the beginnings of volatile interest rates” caused the insurance industry to respond with “the guaranteed investment contract (GIC).” Id. at 13. Forcier gives the following description of the product: “The GIC was the first insurance industry product for the large plan market that actually promised to pay a market rate determined at the time of issuance.

In that context, the use of the term ‘guaranteed’ is defensible: For the first time a large plan product was actually ‘guaranteeing’ interest at a market rate; that is, the insurance company was ‘promising’ (or ‘guaranteeing’) to pay market rates. A number of early GICs were actually called ‘Guaranteed Interest Contracts.’ “Over time, the term ‘Guaranteed Investment Contracts’ became the more commonly used term. But even this development is understandable because professional manag ¹⁹¹ ers tend to view accrued interest as becoming part of the principal. The insurance company was ‘promising’ (i.e., ‘guaranteeing’) to pay both market rate interest and principal.” Forcier, supra, at 16-17.

Walker advises that “[a]s the product matured and as more insurers entered the market place, the GIC became a generic term. Today there are many different types of GICs----” Walker, supra, at 13. Before any DACs, IPGs, or GICs could be delivered in Maryland, the approval of the Commissioner was required. See § 375(a) (“No life ... or annuity contract form ... shall be delivered, or issued for delivery in this State, unless the form has been filed with and approved by the Commissioner.”).

The GICs involved here are ELIC’s form No. 643-11/85, which was approved by the Commissioner on March 17, 1986. The record in this case does not reflect whether, and if so, when, a GIC similar to the ELIC GIC might earlier have been approved in Maryland. Policy approval, of course, is not conclusive of statutory conformity. It is clear that previously approved policies offered by admitted companies for delivery in Maryland may fail to comply with the Insurance Code or other applicable statutes.

See, e.g., Van Horn v. Atlantic Mutual Ins. Co., 334 Md. 669, 686 , 641 A.2d 195, 203 (1994) (“Attempts by insurance companies, purporting to exercise contract rights, to avoid the public policy of compulsory motor vehicle insurance with mandated coverages, have repeatedly been rejected by this Court.”). Nevertheless, on the issue of whether a given policy complies with the Insurance Code, the determination of the Commissioner initially to approve the policy form, coupled with the absence of any exercise by the Commissioner of the § 375(b) power to withdraw approval, is entitled to weight in ¹⁹² construing the statute that the policy form allegedly violates. 6 See Hammon v. Farmers Ins. Co. of Idaho, 109 Idaho 286 , 707 P.2d 397 (1985); Department of Ins. of Indiana v. Church Members Relief Ass’n, 217 Ind. 58 , 26 N.E.2d 51 (1940); Drogula v. Federal Life Ins.

Co., 248 Mich. 645 , 227 N.W. 692 (1929); Clark v. Federal Life Ins. Co., 193 N.C. 166 , 136 S.E. 291 (1927); Colangelo v. Bankers & Shippers Ins. Co., 185 N.J.Super. 205 , 447 A.2d 1356 (1982); Mutual Benefit Life Ins. Co. v. Welch, 71 Okla. 59 , 175 P. 45 (1918); Manhattan Life Ins.

Co. v. Wilson Motor Co., 75 S.W.2d 721 (Tex.Civ.App.1934). The Commissioner was, and is, also charged with the duty annually to “value, or cause to be valued, the reserve liabilities (hereinafter called reserves or net value) for all outstanding life insurance policies and annuity ... contracts of every life insurer doing business in this State____” Md.Code (1979 Repl.Vol.), § 83(1). In 1979, an actuarial committee of the American Council of Life Insurance proposed modifying the standard valuation law by a new approach to the “prescription of the statutory maximum valuation interest rates.” Letter from Yuan Chang, Vice President, Travelers Insurance Company, to the members of the Society of Actuaries (Oct. 19, 1979), Attachment E-l to the report on amendments to the Standard Valuation Law and to the Standard Nonforfeiture Law, by the NAIC Technical Task Force on Valuation and Nonforfeiture Value Regulation, 1980-1 NAIC Proc. 515, 571. The amendments were proposed, at least in part, because “new product development in the pension field created certain